Positioning and FX Technical Outlook: More Correction Ahead

The latest CFTC Commitment of Traders report covers the week ending June 5. We assume that the report's coverage of speculative positioning is representative of short-term trend followers and momentum players. There were several noteworthy developments among speculative participants in the futures market. The highlights include:

New record short euro position

A switch from net short to net long yen

A switch from net long to net short sterling

New record short Australian dollar position

The general technical outlook appears constructive. We continue to expect additional position adjustments ahead of the Greek elections (and French elections) on June 17. This will mean mostly a weaker dollar, except against the yen, as cross positions are also adjusted. Those currencies that were beaten down the most in May are candidates for out performance during this correction phase. Indeed, this has been the case in thus far this month. The order from best to worst performers in May (yen, Canadian dollar, sterling, franc, euro and Aussie) have been reversed perfectly except the juxtaposition of the Canadian dollar and sterling (Aussie, euro, franc, Canadian dollar, sterling and yen).Euro: The net short position rose by 11k contracts to 214.4k. This is represents a new record short. The gross longs were cut by 3.6k, perhaps taking advantage of the modest bounce after the soft US jobs data to get out, or perhaps they had capitulated int the days prior to the employment report. The gross shorts grew by 7.3k to 251.1k, which also represents a new record. Obviously a large short position does not mean the currency must bounce. It is important to keep in mind that the foreign exchange market is primarily an over-the-counter market and at an estimated $4 trillion a day in turnover is the largest of the capital markets. That said, we still expect that ahead of the Greek elections on June 17 further position squaring. Last week, we noted the key reversal in the euro daily bar charts and suggested potential to $1.2620. This past week's high as $1.2625. The euro subsequently fell following Bernanke's failure to unequivocally endorse QE3 and Spain's credit rating was slashed by 3 notched by Fitch. However, provided the euro holds above $1.2420, a new leg up is likely. The $1.2620 area remains important, but if this is taken out $1.2670 becomes the next immediate hurdle, but there is potential toward $1.2780-$1.2800. The technical condition of the euro may be improving and in the coming days the 5-day moving average is likely to rise through the 20-day average, for the first time since early May.Yen: The net speculative position switched from short yen (contracts) to long yen (12.1k contracts). It is the first time the speculative position is long yen since late February. The shorts were cut by 7.6k contracts and the longs grew by 15.8k. Ironically, we suspect the long yen positions are vulnerable. The technical tone of the yen is poor and the US dollar appears to have bottomed on June 1 near JPY77.65. Support is now pegged near JPY79. Although JPY80 represents a psychological hurdle, we see potential toward JPY81.00. The dollar's 5-day moving average is set to rise above the 20-day moving average for the first time in more than two months.Sterling: The speculative position swung back to a net short position in sterling in the week ending June 5. It is net short almost 3k contracts after being long 1.5k in the previous period. It had been net long since late April. Both longs and shorts rose. The longs by 2.9k and the shorts by 7.3k contracts. Sterling's technical tone does not appear as strong as the euro nor as weak as the yen. Provided sterling holds above $1.5370, it has potential to continue to retrace the April-May slide and recover toward $1.57.Swiss franc: The change in the speculative positioning in the Swiss franc futures was unremarkable. The net short position rose to 33.6k from 30.6k contracts. This was a function of longs being cut (-1.1k) and shorts increasing (1.9k). Like the euro, against which the franc looks pegged not just capped, staged a key reversal after the disappointing US jobs data and recorded follow through gains over the next several sessions. The outlook is essentially the same as the euro. Assuming the CHF0.9700 area holds dollar gains, the greenback can slip toward CHF0.9500 and possible CHF0.9400 during this corrective period. The 5 and 20 day moving averages will likely cross in near-term.Canadian dollar: Besides the yen, the Canadian dollar is the only other currency future that the speculative community remains net long. The net long position has been trending lower in recent weeks. In the most recent period it fell almost 20k contracts to just less than 15k. It is the smallest net long position since late February. Longs look have have simply reversed as they were cut by 9.2k and the shorts rose by 9.9k. The Canadian dollar generally trended higher last week, but sold off on June 8. The US dollar bounce stopped just where it had to if the Canadian dollar is going to continue to recoup of the ground it lost in May. The CAD1.0355 area is important resistance now for the greenback. During this corrective phase, look for the US dollar to fall through CAD1.02 and test the CAD1.01 area..Australian dollar: The net Australian dollar position extended its record short to 51.2k contracts from 35.5k. This reflected 2.2k long contracts capitulating, while the shorts piled up another 13.4k to a new record 63.8k contracts. Consider that until recently, the largest net short position since at least 1993 was recorded in 2006 just below 32k contracts. A 25 rather than a 50 bp rate cut, stronger than expected Q1 GDP, May job growth and, arguably unexpected Chinese rate cut helped spark a rally in the Australian dollar. The $1.000 are largely held on the first attempt, but provided the $0.9800 area holds, parity can be re-tested and the correction could see the Aussie trade toward $1.01-$1.02. The 5-day average crossed above the 20-day average on June 8 for the first time since early May, reflecting the improved technical tone.Mexican peso: The net short speculative peso position rose to its largest since last December in the week ending June 5, which itself was the largest net short since 2004. It was proportionately a large move. The net short position swelled to 30.4k contracts from 13k. The peso price action is consistent with the other currencies--generally strengthened last week before seeing those gains pared at the end of the week. The US dollar high on June 8 is important. It corresponds to a retracement level of the greenback's losses in the preceding days. If this technical analysis is right, the dollar could fall toward MXN13.75 and possibly MXN12.55.